A Conditional Markov Regime Switching Model to Study Margins: Application to the French Fuel Retail Markets

This paper uses a regime-switching model that is built on mean-reverting and local
volatility processes combined with two Markov regime-switching processes to understand
the market structure of the French fuel retail market over the period 1990-2013. The volatility
structure of these models depends on a first exogenous Markov chain, whereas the drift
structure depends on a conditional Markov chain with respect to the first one. Our model
allows us to identify mean reverting and switches in the volatility regimes of the margins.
In the standard model of cartel coordination, volatility can increase competition. We find
that cartelization is even stronger in phases of high volatility. Our best explanation is that
consumers consider volatility in prices to be a change in market structure and are therefore
less likely to search for lower-priced retailers, thus increasing the market power of the
oligopoly. Our findings provide a better understanding of the behavior of oligopolies.